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Derivatives are assets that derive their value from an underlying asset. A commodity future derives its value from its underlying commodity and is a derivative contract. A swap is a derivative instrument that involves two parties exchanging certain benefits to either hedge their inherent risk or to speculate. Swaps can be based on interest rates, foreign exchange rates, equities and trading commodities.

Swap Contracts and Portfolio Management

Swaps are initiated with a zero value and their payoffs change as the value of benefits exchanged changes. A notional principal is the amount on which the swap contract is based and is determined at the time of the initiation of a swap contract, it is called a notional principal because the principal is generally not exchanged between the parties except sometimes in the case of currency exchanges.

Calculating Returns to Futures Trade of Swaps

Step 1

Determine the notional principal of a swap mentioned in the swap agreement. For this example, suppose a notional principal of $100,000.

Step 2

Find the current rate from an appropriate finance website such as MSN Money, Yahoo! Finance or The Wall Street Journal. In this example, assume an interest rate swap with the current market interest rate at 8%.

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